Implications of the recently approved tax laws and possible implications on commercial real estate

1. Implications of Tax Cuts on
Commercial Real Estate
December 2010
Jeffrey Kottmeier, Director of Research, DC Region
As the 2001 and 2003 Bush era income tax cuts near expiration on December 31,
Congress and the President are rushing to reach consensus on extending those tax cuts
before the start of a new year. With the federal debt climbing to $13.9 trillion, up 14
percent compared to a year ago, many are concerned about what impact any tax cuts
will have on a slowly recovering economy.
Additionally, the longevity of those tax cuts is a major factor in the current fiscal and
political debate. One argument posits that allowing them to become “permanent” could
have long-term effects on the federal deficit. Extending current income tax cuts would
cost the Federal Government an estimated $3.7 trillion over 10 years. Many politicians
regardless of party affiliation support extending tax cuts for a shorter period of two
years. That would reopen the tax debate during the 2012 elections.
2011 Tax Brackets The President and leaders of the Republican Party crafted a bipartisan proposal to
extend most of the current tax cuts for two years. This proposal has yet to be voted
Expire Current Extend Current Expire Current on by Congress. No matter what the outcome is, tax regulations have significant
Cuts for All Cuts for All Cuts for Wealthy*
implications on the US economy and commercial real estate. Below we take a look at a
10.0% 10.0%
couple of possible scenarios.
15.0% 15.0% 15.0%
28.0% 25.0% 25.0% Income Taxes – Bush era income tax cuts are extended for some or all. Most
31.0% 28.0% 28.0% politicians have agreed on tax cuts for the middle class, but those for the wealthy
36.0% 33.0% 36.0%
(individuals earning $200,000+ annually or $250,000+ for couples) have been more
39.6% 35.0% 39.6%
controversial. Cutting taxes for wealthy households would mean that the top two income
tax rate brackets would increase from 33 and 35 percent to 36 and 39.6 percent. The
* Single with income over $200,000 or Married Filing Jointly
with household income over $250,000
US Treasury estimates the cost of permanent tax cuts for all taxpayers would equal
Note: Taxable income ranges change, depending upon law $3.7 trillion over 10 years, of which $700 billion would be from cuts for the wealthy.
approved
The most likely outcome appears to be that tax cuts will be extended for everyone, but
Source: Tax Policy Center only short-term. Cost estimates for a one to two year tax cut for all households range
between $200 billion to $500 billion.
Capital Gains – Long-term capital gains and qualified dividends taxes remain
unchanged. Currently, long-term capital gains and qualified dividends are taxed up to
Maximum Tax Rates
15 percent. If the present tax cuts expire, the rates would revert to pre-2003 levels
80% of 20 percent for capital gains and regular income tax rates (up to 39.6 percent)
70%
60%
for dividend income. That could encourage high-income taxpayers to change their
50% investment strategies. Those anticipating higher taxes in the future may realize more
40% long-term gains in 2010 and fewer in 2011. This could shift some commercial real
30%
20%
estate transactions into 2010, as capital gains are taxed at a lower rate. The latest
10% bipartisan proposal is a short-term extension of the current capital gains tax laws.
0%
Mortgage Interest Deductions – Residential mortgage interest deductions are phased
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Personal Income Long-Term Capital Gains
out or eliminated. With a housing market struggling to recover, the elimination or
Sources: Department of Treasury, Office of Tax Analysis; Tax
phase out of mortgage interest deductions (MID) is highly contested. Changes in the
Foundation MID would have many implications on housing markets and federal tax revenues. We
estimate the total amount of interest deductions for existing US condominium and co-
op sales in 2009 is to have been $1.3 billion, based on an average unit sales price of
$217,000.
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2. Implications of Tax Cuts on
Commercial Real Estate
December 2010
Limiting Itemized Deductions – Another proposal to limit the value of itemized
deductions to 28 percent would affect high-income earners. The Tax Policy Center
estimates limiting deductions to 28 percent would increase federal taxes by $27,000, on
average, for those earning over $1 million.
Estate Taxes – The top estate tax rate decreases to 35 percent and exemptions
increase to $5 million. In 2010, there are no federal estate taxes due to a phase-out
schedule established in 2001. In 2009, couples qualified for a $7 million tax exemption
($3.5 million for individuals) to distribute their estates, and amounts over $7 million were
taxed up to a top 45 percent tax rate. Current law has the estate tax resuming in 2011,
which includes a lower tax-free allowance of $1 million per person and a higher top tax
rate of 55 percent. Making the estate tax permanent using 2009 parameters would cost
$265 billion.
Implications
Debt/GDP
Public debt has increased significantly over the past few years due to increased federal
spending. Currently, federal debt accounts for approximately 64 percent of GDP. A
congressional panel on debt reduction recently suggested recommendations that would
cut $4 trillion from the federal deficit through 2020, reducing the deficit to 2.3 percent
of GDP by 2015, and reducing public debt to 40 percent of GDP by 2035. Concerns
over the tax cuts stem from how heavily debt will weigh on the nation’s economic output.
Short-term, economists estimate that the proposed temporary tax cuts and spending
increases will help boost the economy in 2011. The latest estimates by Moody’s
Analytics show that extending tax cuts would accelerate real GDP growth to 4 percent
in 20111 . Longer-term tax cuts would add to the public debt. Making the 2009 tax code
permanent would decrease federal revenues by $234 billion over 10 years according to
the Tax Policy Center.
1
Mark Zandi, “Tax Deal Improves Odds for U.S. Economy in 2011”, Moody’s Analytics, 7 December 2010.
GDP & Tax Rates
’81 Tax Cuts Revenue Reconciliation Act ‘93
10% 18%
’01 & ’03 Bush Tax Cuts
Tax Reform Act ‘86
8% 16%
14%
6%
Real GDP, Y/Y Change
12%
4%
Tax Rate
10%
2%
8%
0%
6%
-2%
4%
-4% 2%
-6% 0%
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US GDP (Ch. 2005 $, SAAR) Average Income Tax Rate
Sources: Bureau of Economic Analysis, Moody’s, Bureau of the Public Debt Online
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3. Implications of Tax Cuts on
Commercial Real Estate
December 2010
Employment
Commercial real estate demand is highly dependent upon job creation. Employment
National Employment dropped drastically during the 2007-2009 recession. National employment levels
for Professional & Business Services, a key driver of office sector demand, bottomed
18 out in 3Q 2009, while employment in the retail and manufacturing sectors troughed
17
in 4Q 2009. Since then, employment has improved in all three sectors. Changes
Millions Employed (SA)
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in the tax code could affect the outlook of businesses toward hiring additional, full-
14 time employees, thus altering demand for commercial real estate. Moody’s Analytics
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estimates that an additional 1.6 million jobs could be added in 2011 by extending tax
11 cuts and increased spending. Historically, office using jobs account for 20 percent of
10
job growth. This would equate to an additional 320,000 office using jobs for the US
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economy.
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Retail Professional & Business Services Manufacturing
Source: Bureau of Labor Statistics Small Businesses
Many small business owners could be significantly affected if some current tax laws are
allowed to expire on December 31. If personal income tax rates and capital gains rates
increase, capital expenditures and small business employment could suffer. Nationally,
employment for small businesses with fewer than 50 employees has already decreased
Income Taxes Down, Small Business by 1.9 million workers over the past two years. Placing a larger tax burden on small
Employment Up
business owners could spur a continuation of this downward trend.
40% 15
14.5
Consumer Spending
39%
38%
14 Many argue that an increase in taxes will restrain consumer spending, hampering a
Millions Employed
Income Tax Rate
13.5
37% 13 full economic recovery. History shows that decreases in the average income tax rate
36% 12.5
35% 12
have coincided with increased consumer spending. With a recent pick-up in consumer
34%
11.5
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demand, the retail and manufacturing sectors have shown some signs of improvement
33% 10.5 that could fade if tax rates suddenly increase.
32% 10
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Other Implications
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Total Employed (Businesses <50 Employees) Top Income Tax Rate
There are many other issues about current tax laws being debated that could impact
Sources: Bureau of Labor Statistics, Moody’s, Internal
Revenue Service the decisions businesses make about hiring, investing and operating. One such issue
is whether or not to extend tax deferrals on profits. Companies could use this deferral
to finance equipment or other large purchases. Another issue is higher taxes on carried
interest. In investment partnerships, carried interest is a form of profit-sharing for the
firms’ general partners. Carried interest can qualify for lower capital gains rates. These
Income Taxes Affect Consumer policies and others will affect the amount of money businesses, investors, and owners
Expenditures retain, and thus have an impact on business activities including the investing in and
leasing of real estate. With the final verdict still out on tax laws, the clock is ticking
$60,000 18%
$50,000
16% quickly towards midnight on New Year’s Eve.
14%
$40,000 12%
10%
$30,000
8%
$20,000 6% Disclaimer
4%
$10,000 This report and other research materials may be found on our website at www.cassidyturley.com. This is a
2%
$0 0% research document of Cassidy Turley in Washington, DC. Questions related to information herein should be
directed to the Research Department at 202-463-2100. Information contained herein has been obtained
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Av Annual Consumer Expenditures ($) from sources deemed reliable and no representation is made as to the accuracy thereof. Cassidy Turley is a
Av Federal Income Tax Rate (%)
leading commercial real estate services provider with over 2,800 professionals in 60 offices nationwide. The
Sources: Bureau of Labor Statistics, Moody’s, Tax
Foundation
firm completed transactions valued over $13 billion in 2009, manages over 420 million square feet on behalf of
private, institutional and corporate clients and supports over 25,000 domestic corporate services locations.
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